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Providence Financial









MONTHLY NEWSLETTER:  JUNE 2006 ISSUE

CHARTER FINANCING IS TOO EXPENSIVE
BY BRENT VAN ALFEN, PROVIDENCE FINANCIAL COMPANY, INC.



I have recently undertaken an exhaustive study of charter school facility financing costs to see if I can quantify some information that will help me in an effort to find ways to lower these costs industry wide. I am grateful for the people at Thomson.com for their assistance in providing this data. Thomson.com is an excellent source of information on a broad spectrum of subjects.

There is no question that charter schools are paying too much for their facilities financing. Every aspect of pricing in this business is either directly or indirectly a function of perceived risk on the part of the lender or underwriter. Since the charter school industry is still fairly new, there is not much historical data for underwriters and credit analysts to rely on for their decisions. The risks are therefore considered to be relatively high, so there is a premium built into charter offerings to attract investors. Three of the main sources of facility financing costs are the interest rate, reserve accounts, and costs of issuance.

Interest Rate

The interest rate itself needs no explanation, but there is one factor that directly affects the rate that we must be aware of. It is called the “Original Issue Discount.” This is a deduction from face value in the amount investors pay for the bonds. For example, if the bond’s denomination is $100 and it is sold for $97.50, that is the discount--but you are still expected to pay back the $100. It is used to adjust the interest rate to the investor when necessary to sell the bonds. I have seen it affect the true interest rate as much as one-third of a percent. According to my study, interest rates appear to be highest in New York and lowest in Colorado where the state has done some things to help charters get lower cost financing.

Reserve Accounts

These are funds that were received from bond sales but held back from disbursement to the project and placed in a trust account. They may be held for various purposes, but they are primarily for the purpose of making payments if the school is not able to. They affect the cost of borrowing because the school is paying interest on money they do not get to use. While interest is paid to the school on this money, it is rarely, if ever, as high as the interest rate the school is paying. Any way you dress it up, it is still a cost to the facility financing and increases the mortgage payment. In my research, it appears that reserve accounts average the highest as a percent of gross proceeds and project proceeds in Arizona. They appear to be lowest in Florida. The range of the lowest average to the highest average is 4.72% of the gross proceeds and 6.37% of the project costs. That is a big spread! At this stage of the market cycle, there is little chance of avoiding reserve accounts entirely, but some underwriters are getting carried away with them.

Every aspect of pricing in this business is either directly or indirectly a function of perceived risk on the part of the lender or underwriter.

Cost of Issuance

This represents the total of the costs of attorneys, underwriters, advisors, and other professionals who take part in making the underwriting a success. You cannot get the job done without them but care must be taken to control these costs. The data I collected suggests that these costs are highest in Texas with Michigan a close second. They appear to be lowest in California. The range of the lowest average to the highest average is 7.66% of gross proceeds and 10.95% of project costs. That is a whopping spread!

I am going to keep digging through this mind-numbingly boring stack of numbers to see what else I can glean that may be worthwhile to you; but, for now, I am going to quit so there will be enough room for Dr. Tucker’s article, which I think will be of real value to you.